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Saudi Arabia vs US Shale Producers: Who Wins the Oil Rout?

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Surplus crude is playing havoc on oil prices since mid last year, and producers that contributed to the glut have been tagged as the main culprits. In this study, we identify the key players responsible for the shortage to surplus situation and those that have remained unscathed by the carnage.

Oil Surplus: The Offenders

Oil hovered around $110 each barrel from mid of 2011 to the middle of 2014. Those were definitely the best days for oil producers as they could sell crude at higher prices. This lucrative business environment attracted investments in the oil field and led to the shale revolution.

The word revolution generally means a dramatic change in conditions or operations. So what changes did the shale revolution bring for the energy space?

To bank on high oil prices, oil producers in the U.S. started using new technologies like hydraulic fracturing (or fracking) – a method used to extract oil by blasting underground rock formations with a mixture of water, sand and chemicals – and horizontal drilling.

This allowed them to produce shale oil on huge scale uninterruptedly. In fact, U.S. shale producers drilled more than 20,000 new wells since 2010 as per media sources. This boosted America’s production by more than 33%, which is remarkable.

We should also highlight that the Organization of the Petroleum Exporting Countries (OPEC) – mainly dominated by Saudi Arabia – was responsible for the crude glut too. But the primary reason for the oversupply seems to be the boom in U.S. shale production.

Going Deep into the Story

This led to a 60% plunge in crude prices below levels prevailing in mid 2014. West Texas Intermediate (WTI) crude closed at $43.08 – the lowest level since Mar 11, 2009 – on Tuesday compared with $100 per barrel plus prices prevailing in July last year. Weak crude also hurt profits of oil majors like Exxon Mobil Corporation (XOM - Free Report) , Chevron Corporation (CVX - Free Report) , Royal Dutch Shell plc (RDS.A - Free Report) and BP plc (BP - Free Report) . Each of these oil giants witnessed year-over-year decline in earnings during second-quarter 2015.

Not only has the crude price decline snatched away millions of dollars from crude producers, in particular the U.S. shale producers, it has also led to resulted in ballooning debts. More importantly, shale-oil wells have a short life span and need a regular flow of investment for continued production. Hence, investing on a regular basis, especially when business is not thriving, is the toughest job for U.S producers.

Meanwhile, Saudi Arabia has remained unfazed by the plunge in crude price as it needs only $5–$6 to produce a barrel of oil. The country can’t care less about producing less oil to take crude price to its past glory.

Instead, Saudi Arabia believes that oil prices will recover only when producers struggling to tide over low commodity prices are out of business. To say it another way, only those who sustain should     survive.

Now, does this strategy aim at pushing U.S. oil producers out of the market?

Survival of the Fittest

As of now, Saudi Arabia seems to be best positioned to survive low oil prices as it needs to spend a negligible amount on pumping oil from wells. In fact, the country never reduced crude output and instead kept on producing more amid sluggish global demand. With this strategy, the country has been trying to drag commodity prices downward and aiming to monopolize the oil market by pushing debt-burdened U.S. shale producers out of business.

However, in doing so, Saudi Arabia has also failed to withstand the weak commodity prices. This is evident from the fact that the country has issued bonds worth $5.33 billion to sustain its spending program. To interpret it differently, the free fall in crude prices has also lowered revenues of Saudi Arabia, the top exporter of oil in the world significantly. This was what called for the huge bond issuance.

Without doubt, everybody will accept that producers of oil in the U.S. are also struggling to keep their head above water with plummeting top and bottom lines in the past two quarters. But we do believe that eliminating U.S. oil producers from the energy patch is easier said than done.

This is because the U.S. producers are much more efficient in extracting crude from the oil patch. They employ the latest technologies and methods like fracking and horizontal drilling, and are able to produce oil from the shale plays within a short time frame. On the contrary, Saudi Arabia is not being able to use hydraulic fracturing due to lack of sufficient water needed to blast rock formations to free up oil.

Overall, we can say that both Saudi Arabia and the U.S. are trying their best to compete with each other. If Saudi Arabia enjoys lower production costs, U.S. producers boast higher efficiency levels. And in brandishing their own power, both countries have continued to increase production, pushing crude prices further down.

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